Convertible Securities

Describe the call feature. Does call become more/less likely when interest rates increase/decrease, when the price of common stock increases/decreases?

Call Feature- forces bond holders to convert to stock. It gives the issuing firm the right to buy back the debt for a fixed amount of money. Interest rates decrease, firm is more likely to call. Stock price increases, firm is more likely to call.

Define conversion ratio and conversion price.

Conversion Ratio- number of common shares each bond could be exchanged for. Conversion Price- the price paid for each share of common stock upon conversion.

Recognize the four possible outcomes for a convertible bond.

Conversion, call, retirement at maturity, default

Know the features of convertible bonds and convertible preferred stock. How is convertible preferred different from convertible bonds?

Features of convertible bonds: may be converted at bondholder's option into a specified number of shares of common stock, interest (coupon), maturity date, call feature, indenture, one-time/ one-way conversions Features of convertible preferred stock: "same" instrument is equity, pays fixed dividend, lacks safety associated with debt, more risky

Given the conversion ratio, the price per share of common stock, and the current market price (or call price) of the convertible bond or convertible preferred, decide whether or not the investor should convert.

Price per share increases, value of bond increases. (DO NOT CONVERT) Price per share decreases, value of bond decreases. (CONVERT TO STOCK)

How does the value of convertible bonds (convertible preferred) respond to changes in interest rates and changes in price per share of common stock?

Value rises

What determines the value of a convertible bond (convertible preferred) if the conversion decision must be made immediately?

Value would be equal to the maximum of: 1. the value of the bond as debt 2. the value of the bond if converted to stock